5 MOL! – Allocative Efficiency3 min read

If every point on the PPC is productive efficient, are all the points equally good?

ACOn the diagram, points B and C are productive efficient as all the resources are fully utilised. This doesn’t help answer the economic problem of what and how much to produce. Should the economy produce at point B, C or on some other point? Hence, another yardstick is required to measure the efficiency of the economy.

Definition

Allocative efficiency gives us economists a new way to measure the state of the economy. Allocative efficiency is a situation where the combination of goods and services produced and consumed maximises society’s welfare. By this definition, only one point on the PPC is allocative efficient.

Which point is allocatively efficient?

Just think about it logically: at a class outing, half of your friends want Hawaiian Pizza and the other half wants Pepperoni Pizza, how many of each pizza will you order? Assume that you can afford 10 pizzas and both types of pizza cost the same and that you value your friends’ preferences equally.

You will try to get 5 each.

Since the combined preferences for both pizza are assumed to be the same, buying more or less of one type of pizza will cause one group to be more unhappy and the other to be slightly happier. As a result, there is a net loss in the satisfaction among the group.

Confusing? Don’t worry about it for now. We will explore this in much greater depth in subsequent posts.

Is the point a constant?

No it’s never a constant, in fact it’s constantly changing over time. The PPC can shift as you have learnt last week and that will cause the socially optimum point to shift. In the scenario above, it corresponds to the situation where the pizzas are no longer priced the same.

But perhaps more importantly, preferences can evolve over time as products leave and enter the market. This might correspond to the Hawaiian Pizza getting replaced by a vegetarian pizza and now fewer people want that option.

That being said, in most analyses we will assume that the point of allocative efficiency is fixed. In other words, we are performing a static analysis instead of a dynamic one. Another way to think about it is that are looking at the Long Run Equilibrium of the situation.

In summary, only one point on the PPC is allocatively efficient and this point is changing over time.

Question of the Day

Answers will be given tomorrow.

Which point on the PPC is allocatively efficient when the socially optimal ratio of consumption of Bread is to Tractor is 7 : 1.

The answer to Saturday’s question is E — All of the above.

Further Questions

  1. A similar but different concept to allocative efficiency is the idea of Pareto efficiency. While this is not in your syllabus, it’s important to know the distinction because many sources actually get this point muddled up as well. Google Pareto Efficiency. What’s the difference between Pareto and Allocative efficiency? (Hint: One of them is a stronger condition that implies the other. i.e. one is a subset of the other.)

  2. Can the allocative efficient point be not on the PPC?

  3. Suppose we redistribute wealth from the rich to the poor. Will the allocatively efficient point shift?

  4. (Extremely difficult & Out of Syllabus — try this if you are doing H2 KI) What exactly is societal welfare? Is it even possible to measure it? What sort of assumption are we making when we define a concept like this?

We look forward to seeing your responses in the comments section below!

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Till next time, dream economics.

Mistakes are proof that you are trying

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